Returns to Capital in Microenterprises: Evidence from a Field Experiment^*

Abstract

Small and informal firms account for a large share of employment in developing countries. The rapid expansion of microfinance services is based on the belief that these firms have productive investment opportunities and can enjoy high returns to capital if given the opportunity. However, measuring the return to capital is complicated by unobserved factors such as entrepreneurial ability and demand shocks, which are likely to be correlated with capital stock. We use a randomized experiment to overcome this problem, and to measure the return to capital for a sample of microenterprises. We accomplish this by providing cash and equipment grants to small firms in Sri Lanka, and measuring the increase in profits arising from this exogenous (positive) shock to capital stock. We find the average real return to capital to be 4.6 to 5.3 percent per month, substantially higher than the market interest rate. We then examine the heterogeneity of treatment effects to explore whether missing credit markets or missing insurance markets are the most likely cause of the high returns. Returns are found to vary with entrepreneurial ability and with household wealth, but not to vary with measures of risk aversion or uncertainty. Treatment impacts are also significantly larger for enterprises owned by males, and indeed, we find no positive return in enterprises owned by females.

Incentives and the De Soto Effect

“…To derive estimates of the key parameters, we use data from a study of Sri Lankan microenterprises by De Mel, McKenzie, and Woodruff (2008) (MMW hereafter). They surveyed 408 microenterprises 17 in the three southern and southwestern districts Kalutara, Galle, and Matara.…”

“…We use the model to derive predictions on the effect of improving property rights on credit contracts in an equilibrium setting. We then explore these effects quantitatively using a data set from Sri Lanka collected by de De Mel et al (2008) which conducts an experiment which can be used to deduce a key structural parameter in our model. The quantitative analysis shows that the effect of property rights improvements is likely to be both non-linear and heterogeneous.…”

Employment Generation in Rural Africa: Mid-Term Results from an Experimental Evaluation of the Youth Opportunities Program in Northern Uganda

“…13 The m odel was devel oped by the authors along with Julian Jamison, for a seri es forthcoming s of col laborative projects and papers. It could be considered a two-period version of the one-period entrepreneurial investment choice model proposed by Mel et al (2008), or a cash transfer version of the two-period microcredit model proposed by Banerjee et al (2010). Cre dit constraints are no t the only potential market imperfection.…”

“…One is risk and imperfect insurance. de Mel et al (2008) examine a model where households are risk averse and insurance markets are imperfect, and show that the gap between the market interest rate an d the marginal return to capital are in creasing in the level of risk in business profits and in the level of risk aversion displayed by the household. More risk averse individuals should benefit more from cash transfers.…”

“…While the number of data points remains small, there is a growing sense that the poor have high returns to cash and in-kind physical capital. Economic theory and some experimental evidence suggest that these returns go unrealized because the poor have little capital of their own to invest and limited access to credit (Banerjee and Duflo 2005;Udry and Anagol 2006;de Mel et al 2008;Banerjee et al 2010). …”